November Tax Decisions
January 18, 2022
U.S. District Court upholds IRS motion for summary judgment on valuation of shares in family business for estate tax purposes in Connelly v. United States, 4:19-cv-01410-SRC (E.D. Mo. Sept. 21, 2021).
In Connelly, the estate Taxpayer and IRS both filed motions for summary judgment on the issue of whether life insurance proceeds payable to a closely-held entity—used to fund a share buy-back after a shareholder’s death—should be included in the value of the company. The business at issue was owned by two brothers. The stock purchase agreement between the brothers required the company to buy back the shares of the first brother to die. One brother died in 2013, and the entity repurchased the deceased brother’s shares for $3 million. His estate paid taxes on the sale of his shares in the company.
But the IRS assessed additional estate taxes of over $1 million. The estate paid the tax due and filed a refund suit. The main issue was the proper valuation of the company as of the date of the brother’s death—namely whether life insurance proceeds should be included in the valuation for estate tax purposes. On the date of death, the company was worth approximately $3.3 million (not including life insurance proceeds). The company, on the date of death, was also to receive $3.5 million in life insurance proceeds. Without those proceeds, the company would not have been able to afford to buy back the deceased brother’s shares.
The district court held that the life insurance proceeds were includible in the valuation for estate tax purposes—valuing the company at an additional $3.5 million. Under the Internal Revenue Code, estate tax is levied on the taxable estate that a decedent transfers at death. Included in that estate “is the value of a decedent's gross estate, minus all authorized deductions.” The gross estate includes “property, real or personal, tangible or intangible, as of the decedent's date of death, as defined by statutes and regulations.” The estate includes the value of stock held at the applicable valuation date. The Court’s analysis focused on Treas. Reg. § 20.2031-2, which states, “value of stocks . . . is the fair market value per share . . . on the applicable valuation date.”
The Court further noted specific principles of valuation that apply with respect to buy-sell agreements. “To control the value of a decedent's property for estate-tax purposes, a buy-sell agreement must meet the three statutory requirements of 26 U.S.C. § 2703(b): ‘(1) [i]t is a bona fide business arrangement[;] (2) [i]t is not a device to transfer such property to members of the decedent's family for less than full and adequate consideration in money or money's worth[; and] (3) [i]ts terms are comparable to similar arrangements entered into by persons in an arms' length transaction’” among other additional requirements. The parties disputed whether the stock purchase agreement met all of those requirements.
The IRS ultimately prevailed by arguing that the stock purchase agreement was a device that transferred property to the decedent’s family for less than fair market value. The Court agreed that the initial $3 million valuation did not properly include the additional $3.5 million in life insurance proceeds, which allowed the surviving brother to “obtain a financial windfall at the expense of [the decedent’s] estate.” The Court cited to Estate of Blount v. Comm’r, 2004 WL 1059517, at *26 (T.C. 2004), aff’d in part, rev’d in part on other grounds, 428 F.3d 1338 (11th Cir. 2005). The Tax Court in that case held that life insurance proceeds were includible in the valuation when used to redeem shares, but the 11th Circuit reversed. The Court here declined to follow the 11th Circuit’s reasoning—following the Tax Court’s previous analysis.
A lesson in proper estate planning, Smaldino V. Commissioner of Internal Revenue, T.C. Memo. 2021-127, November 10, 2021.
This Tax Court case underlines the importance of practitioners ensuring that they properly plan and administer a taxpayer’s estate and trust plan. Smaldino owned and operated numerous rental properties. Ten of these properties were put into an LLC, and Smaldino owned the LLC through a revocable trust. Smaldino later transferred approximately 8% of certain LLC membership interests to an irrevocable trust to benefit his children and grandchildren, which he reported on his gift tax return. He then transferred 41% of the LLC interests to his wife, which he did not report on his gift tax return, and his wife then gifted the same interests to the irrevocable trust the next day, which she reported on her gift tax return. The Tax Court questioned the transactions’ legitimacy.
The Tax Court recharacterized the transaction with Smaldino’s wife from a gift to his wife, and a gift from her to the trust, as an indirect gift from Smaldino to the trust, which created significant gift tax liabilities for Smaldino. At the heart of the Court’s analysis was the wife’s testimony. She testified that she made “a commitment, promise” that she would transfer the gift of the LLC interest to the trust. She further testified that she could not have changed her mind, even if she wanted to. In essence, her testimony supported the Service’s argument to ignore the form of the transaction, as she never intended to actually hold or control the LLC interest. This contradicted the purported substance of the transaction. Smaldino and his professionals utilized this mechanism to skip necessary estate planning steps in an attempt to streamline the process.
The gift from Smaldino to the trust was valued at over $7.8 million—exceeding the $5.25 million gift tax exemption in place at the time. The wife had not utilized her gift tax exemption, so the original form of the transaction avoided gift tax (she reported only $5,249,118 in gifts), and Smaldino only reported $1,031,882 in gifts (from the initial gift to the trust)—ignoring the gift to the wife. But under the Tax Court’s view, the entire transaction, in substance, was a gift from Smaldino to the trust, which exceeded his gift tax exemption and resulted in gift tax due.
Bad news for taxpayers in the Fifth Circuit, Non-willful FBAR penalties applied on a “per account” basis in United States v. Bittner, No. 20-40597 (5th Circuit).
In U.S. v. Bittner, the district court had ruled that a $2.7 million FBAR penalty (applying a $10,000 penalty per account) should be reduced to $50,000 based on a $10,000 “per form” cap on non-willful FBAR penalties. The Ninth Circuit, along with district courts in Texas, New Jersey, and Connecticut, had previously ruled in favor of taxpayers that the $10,000 non-willful FBAR penalty was capped on a “per form” basis rather than on a “per account” basis. See e.g. United States v. Boyd, 991 F.3d 1077 (9th Cir. 2021).
The Fifth Circuit declined to follow these taxpayer-friendly determinations in other circuits and even in the local Texas district courts. Instead, the Fifth Circuit held that the $10,000 penalty cap applied on a “per account” basis rather than on a “per form” basis—significantly increasing the penalty cap for taxpayers with numerous FBAR-reportable accounts they non-willfully failed to report.
At issue in this case were Bittner’s non-willful failures to file FBARs. The taxpayer in Boyd, the Ninth Circuit case, had 14 foreign accounts that she failed to report on 13 separate occasions. The resulting penalty was $47,279—applying the penalty on a capped “per form” basis. But Bittner maintained dozens of foreign accounts, sometimes in excess of 50 separate accounts. Bittner argued that the $10,000 “per form” cap should apply, as applied in Boyd. As stated above, the district court agreed with Bittner, but the Fifth Circuit reversed on appeal.
Under the Bank Secrecy Act, a $10,000 penalty is imposed for non-willfully failing to file an FBAR. But the statute says as follows, “the amount of any civil penalty imposed under subparagraph (A) shall not exceed $10,000.” The government argued that the term “any” applies as to each account not properly reported, rather than as to each FBAR containing multiple reportable accounts. Thus, the $10,000 cap, under the government’s theory, would apply as to each account—significantly increasing the maximum non-willful penalty threshold for taxpayers with multiple reportable accounts. Under the Ninth Circuit’s reasoning, Congress had purposely excluded “per account” language from the non-willful provision. The Fifth Circuit took a different stance; reading the statutory framework as a whole, multiple violations could be implied from the statute. The Fifth Circuit believed that the statute requiring taxpayers to report such accounts could be violated on multiple occasions (i.e. by failing to report each separate reportable account), and, in absence of express language otherwise, Congress intended for such violations to be penalized up to $10,000 on each separate occasion.
Bittner also drew attention to potentially “absurd” results if the Fifth Circuit held in favor of the government. Bittner argued that, under this analysis, a non-willful violator with a number of accounts would potentially pay greater penalties than a willful violator—purely based on the volume of accounts involved. But the Fifth Circuit dismissed Bittner’s argument, noting that the government had a legitimate interest “to crack down on the use of foreign financial accounts to evade taxes.” However, the Fifth Circuit otherwise ignored Bittner’s argument regarding the strange calculation issue that would result from the Fifth Circuit’s holding—potentially punishing non-willful failures more harshly than some willful failures. Nonetheless, this has created a circuit split, which may make the issue ripe for decision by the Supreme Court.
IRS not held in contempt for offsetting tax refund against tax debt of a Chapter 13 debtor, Webb v. Internal Revenue Service (In re Webb), Bankr. N.D. W.Va. Adv. Proc. No 21-00014 (November 8, 2021).
In In re Webb, a Chapter 13 debtor filed an adversarial claim to hold the IRS in contempt for improperly offsetting a tax refund against a tax debt. The debtor owed taxes for 2013 and 2018. The IRS filed proofs of claim listing the 2013 debt as an unsecured general claim and the 2018 debt as an unsecured priority claim. Additionally, the IRS also listed the 2019 tax year (not yet due, as the bankruptcy began in November 2019) as an unsecured priority claim along with estimated tax due.
The debtor agreed to pay the 2019 tax debt as a priority claim, and the plan also left all property acquired by the debtor post-petition as part of the bankruptcy estate. In 2021, the IRS offset debtor’s 2020 tax refund against her 2019 tax obligation. The debtor disputed the claim by filing the adversary proceeding to hold the IRS in contempt.
Under the Internal Revenue Code, in the case of a Chapter 13 debtor, post-petition taxes are not incurred by the estate, rather, they are a liability of the debtor. Hall v. United States, 566 U.S. 506, 516 (2012). Here, given that the debtor filed bankruptcy in November of 2019; the 2019 tax year ended after the bankruptcy filing—rendering it a post-petition tax year. However, the IRS’ proof of claim treated 2019 as pre-petition tax year. Nonetheless, the Chapter 13 plan provided that any potential tax refund for the debtor (any property acquired post-petition) would be included in the bankruptcy estate.
Generally, an automatic stay protects debtor from collection action by a creditor during the bankruptcy action and prior to discharge. But there are a number of exceptions. The main exception being that the government may offset, post-petition, any pre-petition debt against a pre-petition claim. The pre-petition debt would be viewed from the government’s perspective (tax refund due to a taxpayer), and the pre-petition claim would be the debtor’s unpaid tax debt. See 11 U.S.C. § 362(b)(26). The same principle applies to post-petition debts and post-petition claims under the mutuality of obligation doctrine.
Here, the plan kept all post-petition property in the bankruptcy estate, and any collection of such property was stayed by the bankruptcy proceeding. But the Court noted that Chapter 13 plan here did not address whether an offset of a post-petition tax refund was allowed. But it is clear that the 2020 refund was a post-petition debt of the IRS, but it was unclear if the 2019 tax debt was a pre-petition obligation of the debtor. Thus, questions remained unanswered by the Court. There certainly appeared to be potential issues of the IRS violating the stay under these facts—offsetting a post-petition debt against a potential pre-petition claim. The Court, instead, took a safe approach to the matter.
The judge denied to hold the IRS in contempt, citing that such a remedy “is a serious reprimand and is appropriate only in the case of a deliberate violation in the face of succinct directions to the contrary.” As such, the judge declined to “discuss the legality of the IRS’[] actions because the Debtor only alleges the [IRS’] actions constituted contempt of the confirmation order.” The proposed remedy was too extreme in the Court’s view, likely because of the complex legal issues underlying the facts and the unanswered question regarding the lack of offset language in the Chapter 13 plan. This issue will hopefully be later answered through a future court proceeding.
The district court held that the life insurance proceeds were includible in the valuation for estate tax purposes—valuing the company at an additional $3.5 million. Under the Internal Revenue Code, estate tax is levied on the taxable estate that a decedent transfers at death. Included in that estate “is the value of a decedent's gross estate, minus all authorized deductions.” The gross estate includes “property, real or personal, tangible or intangible, as of the decedent's date of death, as defined by statutes and regulations.” The estate includes the value of stock held at the applicable valuation date. The Court’s analysis focused on Treas. Reg. § 20.2031-2, which states, “value of stocks . . . is the fair market value per share . . . on the applicable valuation date.”
The Court further noted specific principles of valuation that apply with respect to buy-sell agreements. “To control the value of a decedent's property for estate-tax purposes, a buy-sell agreement must meet the three statutory requirements of 26 U.S.C. § 2703(b): ‘(1) [i]t is a bona fide business arrangement[;] (2) [i]t is not a device to transfer such property to members of the decedent's family for less than full and adequate consideration in money or money's worth[; and] (3) [i]ts terms are comparable to similar arrangements entered into by persons in an arms' length transaction’” among other additional requirements. The parties disputed whether the stock purchase agreement met all of those requirements.
The IRS ultimately prevailed by arguing that the stock purchase agreement was a device that transferred property to the decedent’s family for less than fair market value. The Court agreed that the initial $3 million valuation did not properly include the additional $3.5 million in life insurance proceeds, which allowed the surviving brother to “obtain a financial windfall at the expense of [the decedent’s] estate.” The Court cited to Estate of Blount v. Comm’r, 2004 WL 1059517, at *26 (T.C. 2004), aff’d in part, rev’d in part on other grounds, 428 F.3d 1338 (11th Cir. 2005). The Tax Court in that case held that life insurance proceeds were includible in the valuation when used to redeem shares, but the 11th Circuit reversed. The Court here declined to follow the 11th Circuit’s reasoning—following the Tax Court’s previous analysis.
A lesson in proper estate planning, Smaldino V. Commissioner of Internal Revenue, T.C. Memo. 2021-127, November 10, 2021.
This Tax Court case underlines the importance of practitioners ensuring that they properly plan and administer a taxpayer’s estate and trust plan. Smaldino owned and operated numerous rental properties. Ten of these properties were put into an LLC, and Smaldino owned the LLC through a revocable trust. Smaldino later transferred approximately 8% of certain LLC membership interests to an irrevocable trust to benefit his children and grandchildren, which he reported on his gift tax return. He then transferred 41% of the LLC interests to his wife, which he did not report on his gift tax return, and his wife then gifted the same interests to the irrevocable trust the next day, which she reported on her gift tax return. The Tax Court questioned the transactions’ legitimacy.
The Tax Court recharacterized the transaction with Smaldino’s wife from a gift to his wife, and a gift from her to the trust, as an indirect gift from Smaldino to the trust, which created significant gift tax liabilities for Smaldino. At the heart of the Court’s analysis was the wife’s testimony. She testified that she made “a commitment, promise” that she would transfer the gift of the LLC interest to the trust. She further testified that she could not have changed her mind, even if she wanted to. In essence, her testimony supported the Service’s argument to ignore the form of the transaction, as she never intended to actually hold or control the LLC interest. This contradicted the purported substance of the transaction. Smaldino and his professionals utilized this mechanism to skip necessary estate planning steps in an attempt to streamline the process.
The gift from Smaldino to the trust was valued at over $7.8 million—exceeding the $5.25 million gift tax exemption in place at the time. The wife had not utilized her gift tax exemption, so the original form of the transaction avoided gift tax (she reported only $5,249,118 in gifts), and Smaldino only reported $1,031,882 in gifts (from the initial gift to the trust)—ignoring the gift to the wife. But under the Tax Court’s view, the entire transaction, in substance, was a gift from Smaldino to the trust, which exceeded his gift tax exemption and resulted in gift tax due.
Bad news for taxpayers in the Fifth Circuit, Non-willful FBAR penalties applied on a “per account” basis in United States v. Bittner, No. 20-40597 (5th Circuit).
In U.S. v. Bittner, the district court had ruled that a $2.7 million FBAR penalty (applying a $10,000 penalty per account) should be reduced to $50,000 based on a $10,000 “per form” cap on non-willful FBAR penalties. The Ninth Circuit, along with district courts in Texas, New Jersey, and Connecticut, had previously ruled in favor of taxpayers that the $10,000 non-willful FBAR penalty was capped on a “per form” basis rather than on a “per account” basis. See e.g. United States v. Boyd, 991 F.3d 1077 (9th Cir. 2021).
The Fifth Circuit declined to follow these taxpayer-friendly determinations in other circuits and even in the local Texas district courts. Instead, the Fifth Circuit held that the $10,000 penalty cap applied on a “per account” basis rather than on a “per form” basis—significantly increasing the penalty cap for taxpayers with numerous FBAR-reportable accounts they non-willfully failed to report.
At issue in this case were Bittner’s non-willful failures to file FBARs. The taxpayer in Boyd, the Ninth Circuit case, had 14 foreign accounts that she failed to report on 13 separate occasions. The resulting penalty was $47,279—applying the penalty on a capped “per form” basis. But Bittner maintained dozens of foreign accounts, sometimes in excess of 50 separate accounts. Bittner argued that the $10,000 “per form” cap should apply, as applied in Boyd. As stated above, the district court agreed with Bittner, but the Fifth Circuit reversed on appeal.
Under the Bank Secrecy Act, a $10,000 penalty is imposed for non-willfully failing to file an FBAR. But the statute says as follows, “the amount of any civil penalty imposed under subparagraph (A) shall not exceed $10,000.” The government argued that the term “any” applies as to each account not properly reported, rather than as to each FBAR containing multiple reportable accounts. Thus, the $10,000 cap, under the government’s theory, would apply as to each account—significantly increasing the maximum non-willful penalty threshold for taxpayers with multiple reportable accounts. Under the Ninth Circuit’s reasoning, Congress had purposely excluded “per account” language from the non-willful provision. The Fifth Circuit took a different stance; reading the statutory framework as a whole, multiple violations could be implied from the statute. The Fifth Circuit believed that the statute requiring taxpayers to report such accounts could be violated on multiple occasions (i.e. by failing to report each separate reportable account), and, in absence of express language otherwise, Congress intended for such violations to be penalized up to $10,000 on each separate occasion.
Bittner also drew attention to potentially “absurd” results if the Fifth Circuit held in favor of the government. Bittner argued that, under this analysis, a non-willful violator with a number of accounts would potentially pay greater penalties than a willful violator—purely based on the volume of accounts involved. But the Fifth Circuit dismissed Bittner’s argument, noting that the government had a legitimate interest “to crack down on the use of foreign financial accounts to evade taxes.” However, the Fifth Circuit otherwise ignored Bittner’s argument regarding the strange calculation issue that would result from the Fifth Circuit’s holding—potentially punishing non-willful failures more harshly than some willful failures. Nonetheless, this has created a circuit split, which may make the issue ripe for decision by the Supreme Court.
IRS not held in contempt for offsetting tax refund against tax debt of a Chapter 13 debtor, Webb v. Internal Revenue Service (In re Webb), Bankr. N.D. W.Va. Adv. Proc. No 21-00014 (November 8, 2021).
In In re Webb, a Chapter 13 debtor filed an adversarial claim to hold the IRS in contempt for improperly offsetting a tax refund against a tax debt. The debtor owed taxes for 2013 and 2018. The IRS filed proofs of claim listing the 2013 debt as an unsecured general claim and the 2018 debt as an unsecured priority claim. Additionally, the IRS also listed the 2019 tax year (not yet due, as the bankruptcy began in November 2019) as an unsecured priority claim along with estimated tax due.
The debtor agreed to pay the 2019 tax debt as a priority claim, and the plan also left all property acquired by the debtor post-petition as part of the bankruptcy estate. In 2021, the IRS offset debtor’s 2020 tax refund against her 2019 tax obligation. The debtor disputed the claim by filing the adversary proceeding to hold the IRS in contempt.
Under the Internal Revenue Code, in the case of a Chapter 13 debtor, post-petition taxes are not incurred by the estate, rather, they are a liability of the debtor. Hall v. United States, 566 U.S. 506, 516 (2012). Here, given that the debtor filed bankruptcy in November of 2019; the 2019 tax year ended after the bankruptcy filing—rendering it a post-petition tax year. However, the IRS’ proof of claim treated 2019 as pre-petition tax year. Nonetheless, the Chapter 13 plan provided that any potential tax refund for the debtor (any property acquired post-petition) would be included in the bankruptcy estate.
Generally, an automatic stay protects debtor from collection action by a creditor during the bankruptcy action and prior to discharge. But there are a number of exceptions. The main exception being that the government may offset, post-petition, any pre-petition debt against a pre-petition claim. The pre-petition debt would be viewed from the government’s perspective (tax refund due to a taxpayer), and the pre-petition claim would be the debtor’s unpaid tax debt. See 11 U.S.C. § 362(b)(26). The same principle applies to post-petition debts and post-petition claims under the mutuality of obligation doctrine.
Here, the plan kept all post-petition property in the bankruptcy estate, and any collection of such property was stayed by the bankruptcy proceeding. But the Court noted that Chapter 13 plan here did not address whether an offset of a post-petition tax refund was allowed. But it is clear that the 2020 refund was a post-petition debt of the IRS, but it was unclear if the 2019 tax debt was a pre-petition obligation of the debtor. Thus, questions remained unanswered by the Court. There certainly appeared to be potential issues of the IRS violating the stay under these facts—offsetting a post-petition debt against a potential pre-petition claim. The Court, instead, took a safe approach to the matter.
The judge denied to hold the IRS in contempt, citing that such a remedy “is a serious reprimand and is appropriate only in the case of a deliberate violation in the face of succinct directions to the contrary.” As such, the judge declined to “discuss the legality of the IRS’[] actions because the Debtor only alleges the [IRS’] actions constituted contempt of the confirmation order.” The proposed remedy was too extreme in the Court’s view, likely because of the complex legal issues underlying the facts and the unanswered question regarding the lack of offset language in the Chapter 13 plan. This issue will hopefully be later answered through a future court proceeding.
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For any questions about these decisions or any other criminal or civil tax-related matters,please feel free to contact Ryan Dean at (214)749-2430 or rdean@meadowscollier.com.
